I’ve been presenting “Search Marketing 101 – For Business Managers” in the Northeast. I’ll post some parts of it in our blog.

In this post I’ll cover how to cost justify running a Paid Listing (PPC) campaign as well as how we help clients try to cost justify using a Search Engine Marketing Agency, like us, to run a paid listing campaign for them.

Then within a few weeks I’ll post on how to measure the actual ROI from an ongoing PPC campaign.

Cost Justifying a PPC campaign for online salesHere’s a simple ROI example that I believe came from Google (it was passed along to me by one of our PPC consultants to use) to help cost justify an AdWords campaign.

$1,000 initial investment in AdWords

$1.00 CPC (Cost Per Click) ≥ 1,000 clicks ≥ $1,000 investment

10% conversion rate = 100 sales

Average sale = $100

$1K investment returns $10K in sales

Reinvest profits, increase budget

Basically the above shows in round numbers a very simple ROI example where a $1,000 investment in AdWords generates a 1,000 click-throughs to a site at an average cost of $1.00 per click (CPC).

If this site has a 10% average conversion rate then those 1,000 clicks would lead to about 100 sales.

Continuing on, if the average sale is $100, those 100 sales should lead to $10,000 revenue.

So, the example shows that the $1,000 investment leads to a return of $10,000 in revenue.

You can plug your own numbers in to the example. However I would suggest figuring the approximate gross profit too. Not just the revenue. So for example, if the average gross profit from a sale in the above example is 50% then that $10,000 in sales results in $5,000 in gross profit. In other words, the $1,000 investment results in $5,000 in gross profit.

We believe it’s very important to look at gross profit. When you do you’ll see it can be much more difficult to be successful with paid search marketing if you’re selling products with low profit margins. For example, if the average gross profit from a sale in the above example is 10% then that $10,000 in sales results in only $1,000 in gross profit. However $1,000 was spent on the ads and no profit was made. In reality money was lost because time and/or money was spent running the campaign. Whoops!

Everything needs to be running on 12 cylinders to be successful against even a few savvy PPC competitors, especially at low margins. The PPC campaign must be expertly managed and optimized and the web site must convert visitors at an acceptable rate in order to make money when selling products at low margins against even a few competitors who are doing a good job running their campaigns. You’ll also need a higher volume of sales to cover the costs of running a PPC campaign when selling at lower volumes, whether you run it yourself or use an agency.

Cost Justifying using a Search Engine Marketing Agency to run a PPC campaignThe previous example contains a calculation you can use to cost justify a PPC campaign in general, whether you plan to run the campaign yourself or not.

In this section we’ll present a method to cost justify using a search marketing agency to run your PPC campaign. This example will use a lead generation site rather than a site that sells products or services online.

Most search marketing agencies charge the higher of a monthly minimum fee or 15% to 20% of your ad spend (i.e. the pay per click charges from the ad network such as Google AdWords). We run many campaigns based on this type of fee structure too (However, in some cases we base our fees on performance, such as a commission on sales or leads generated from the campaigns we run).

If you do the math, $1,000 is 15% of $6,666. In other words, once the ad spend reaches $6,666 the monthly fee will be based on the ad spend.

However, in reality, many smaller campaigns never reach the level where the fees are based on the ad spend. This is because when we mange a campaign we’ll keep raising the ad spend (by individual keyword) until we have reached the inventory of keyword clicks available from an ad network (such as Google’s AdWords) that return conversions at an acceptable cost per conversion. For most small campaigns that inventory level is lower than the ad spend level needed to base the agency fee on 15% or 20% of ad spend rather than the monthly minimum. This means the agency fee can be much higher than 15% of ad spend, sometimes as high or higher than 50%.

So it’s best to do your initial cost justification based on the assumption that your campaign may never grow to a point where the agency fee is only 15 or 20% of ad spend. Rather base it on the monthly minimum fee plus a monthly ad spend budget.

Here’s an example based on a real B2B client that sells high-end equipment to manufactures and researchers. The site is a lead generation site. No sales are completed on the site.

For this campaign our monthly minimum is $1,000 per month and we have suggested a $1,000 per month for ad spend during the ramp up period. We decide on an ad spend budget for the initial period while we’re ramping up a campaign, testing, and developing the tracking system that will hopefully allow us to track enough conversions to perform a reasonable ROI calculation based on actual campaign results (I say hopefully because our ability to do this is sometimes complicated by factors such as offline conversions that need to be tracked to some level, such as conversions completed on the phone. In addition, sometimes there are technical issues on the site that need to be addressed to allow us to track conversions, which can take time …. Sounds like a topic for another post in the future).

So, if this campaign runs at the minimum fee of a $1,000 per month with the suggested $1,000 per month for ad spend, can it be successful? The agency fee is 50% of ad spend! That’s $2,000 in total campaign costs per month (ad spend and agency fee).

This client’s sales are typically $25,000 to $60,000. For the calculation we estimated the average sale at $40,000. They make about 30% gross profit on a sale so that’s an average $12,000 gross profit per sale.

With $12,000 in gross profit generated by a typical sale one sale can cover the costs of the PPC campaign for 6 months.

We ask clients to try to estimate the number of leads it takes from each lead generation source on the site and figure that into the calculation.

This client believes they need 5 good leads to turn into one sale (During the campaign we need to determine how good the leads are from each source on the site. More on this in a future post).

So our campaign needs to generate about 5 of 6 good leads in 6 months to break even. Sounds like a “no brainier”. The client agreed and the campaign was started last month.

Here’s a summary of the above cost justification calculation

$2,000 Minimum cost of Search Engine Ad Campaign / Month

5 Good leads typically result in a sale

$12,000 Gross profit per sale

1 Sale covers the cost of 6 months advertising

5 to 6 good leads needed in 6 months

The above gives you a calculation you can use to attempt to cost justify whether a PPC campaign may be able support paying a search marketing company to run it.

Of course you could choose to run the PPC campaign yourself. So here are some things to consider when deciding whether to run the campaign yourself or use a search marketing agency –

Do you have the expertise in house to run a PPC campaign? As we mentioned before, the PPC campaign must be expertly managed and optimized and the web site must convert visitors at an acceptable rate in order to be successful against even a few savvy competitors.

Do you have the time? Estimate the time you’ll need to run your on own campaign. Put some value on this and compare it to the agency’s cost.

Can the agency do a better job than you can in house? In other words can they more than justify their fees? We usually improve the performance of campaigns we take over by factors of 2 to as high as 10 or more (i.e. more conversions at lower costs per conversion). Talk to current and past clients of the agency.